California Focus: Optimism as an accounting tool

According to Gov. Arnold Schwarzenegger, California's financial condition is "fantastic." Spending has been brought under control, the budget has been balanced, and our debt is being paid down. But, as Winston Churchill once said, "It is not possible to state the opposite of the truth with greater precision."

To the governor's credit, he has proposed some long-overdue spending reforms, most notably conforming state welfare-eligibility standards to federal law.

But there's very little else to praise about the governor's handling of the state's finances. In fact, spending is growing faster than it did under his recalled predecessor, Gray Davis. The state is now running the biggest deficit in its history, and the only way it can pay its bills is because of massive borrowing carried over from 2004, contributing to a doubling of the state's debt burden in just three years.

When Gov. Schwarzenegger claims the budget is balanced, he ignores his Finance Department's own figures that report a $7.6 billion shortfall in the fiscal-year 2006 budget ($1 billion worse than Davis' worst year, 2000). His proposed 2007 budget adds $1.9 billion more to the state's ocean of red ink.

The governor justifies his claim that the budget is balanced by concocting a new accounting concept he calls the "net operating deficit." Here's how it works: To enable his claim that he is paying down debt when it is actually increasing, the governor made some prepayments during the past two years - akin to paying more than the minimum balance on your credit cards. But to hide the deficit he created on the other side of the ledger, he simply doesn't enter those payments in the state's checkbook. (Don't try this at home, boys and girls, or you'll be hearing from your bank).

California can get away with such bookkeeping gimmickry for awhile because unprecedented borrowing in 2004 and a revenue windfall last year allowed Gov. Schwarzenegger to begin the year with $10.8 billion in the bank. The state's deficit spending will nearly exhaust that cushion by next year under the governor's proposal.

Meanwhile, borrowing is now completely out of control. When Gov. Schwarzenegger took office, the percentage of the general fund required to make the payments on state bond debt was 3 percent. Since then, that burden has doubled to 6 percent and will exceed 8 percent next year. Put another way, our minimum credit card payment now consumes more tax money than the budget of the entire University of California system.

Ironically, the state's debt-service ratio never exceeded 2.2 percent throughout the 1960s, when California was at its zenith in public-works construction under Gov. Pat Brown.

The new budget purports fiscal restraint - growing the general fund just 1 percent (following a staggering 30 percent increase during the past three years). But this is based on some very shaky assumptions that are very unlikely to materialize.

State revenue in 2006 was projected to grow just 1.2 percent, and actual revenue is now falling behind even this modest goal. The governor's 2007 budget is predicated on robust, 7.1 percent growth next year. If the state's economy merely does not deteriorate any further, it will produce a $7.5 billion deficit - placing the state on the brink of insolvency within 18 months.

But even assuming that every one of the governor's calculations is correct, and the governor's budget is adopted intact, the condition of the state's finances will be this:

•The cumulative four-year general fund deficit under this administration will be $5.2 billion, compared with $4.2 billion during the five years under Gray Davis.

•State general fund spending will have increased at an average annual rate of 7.9 percent, compared with 7.1 percent under Davis.

•The state's debt-service ratio, which Davis reduced from 4 percent to 3 percent, will have more than doubled - and by the following year, nearly tripled.

The Oxford English Dictionary notes that the original meaning of the word "fantastic" as, "existing only in imagination." Perhaps that's what the governor means when describing our fiscal health.

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